Condensed Consolidated Interim Financial Statements

Transcription

1 Íslandsbanki Condensed Consolidated Interim Financial Statements First quarter islandsbanki.is

2 Contents Highlights... Directors' Report... Consolidated Interim Income Statement... Consolidated Interim Statement of Comprehensive Income... Consolidated Interim Statement of Financial Position... Consolidated Interim Statement of Changes in Equity... Consolidated Interim Statement of Cash Flows... Notes to the Condensed Consolidated Interim Financial Statements

3 Highlights Our profile A leader in financial services in Iceland, Íslandsbanki is a universal bank with total assets of ISK 1,088bn and a 25% - 50% market share across all domestic business segments. Building on over 140 years of servicing key industries, Íslandsbanki has developed specific expertise in tourism, seafood and energy related industries. Driven by the vision to be #1 for service, Íslandsbanki's relationship banking business model is propelled by three business divisions that manage and build relationships with the Bank's customers. Íslandsbanki has developed a wide range of online services such as the Íslandsbanki, Kreditkort and Kass apps, enabling customers to do their banking whenever and wherever. At the same time, the Bank continues to operate the most efficient branch network in Iceland through its strategically located 14 branches. For the fifth consecutive year, Íslandsbanki led the Icelandic Customer Satisfactory Index for banks in 2017 and was also named Bank of the Year in Iceland by the Banker. Íslandsbanki has a BBB+/A-2 rating from S&P Global Ratings and BBB/F3 from Fitch. ROE reg. operations CET1 15%² Profit after tax (ISKm) Our Bank 14 branches Market Share¹ Credit Ratings 843 Number of FTE's for parent company at period end 33% 36% 32% individuals BBB+/A-2 Stable outlook SMEs Cost / income ratio³ APP users large companies BBB/F3 Stable outlook 10.6% 11.8% 10.8% 4, % 58.3% 62.7% 69.2% 69.8% 8.1% 8.2% 3,044 3,112 2,073 2,097 1Q17 2Q17 3Q17 4Q17 1Q18 1Q17 2Q17 3Q17 4Q17 1Q18 1Q17 2Q17 3Q17 4Q17 1Q18 REA / total assets (ISKbn) Loans to customers sector split As of Number of FTE' s for Parent Company Excluding seasonal employees 71.0% 70.3% 71.2% 74.9% 73.1% Industrial and transport Other 9% 10% ,029 1,047 1,078 1,036 1,088 Real estate 17% ISK 776bn 38% Individuals 11% Seafood 15% Commerce Total assets REA / total assets and services Loans to customers (ISKbn) Leverage ratio Total capital ratio 78.4% 78.0% 76.9% 74.0% 71.5% 15.5% 15.7% 15.3% 16.2% 14.3% 23.1% 23.5% 22.7% 24.1% 21.4% Loans to customers Deposit to loan ratio Financial Statements first quarter ¹Based on Gallup survey regarding primary bank. ²Earnings on regular income now includes profit from discontinued operations. ³The cost / income ratio for the parent company is 64.4%

4 Directors' Report These are the condensed consolidated interim financial statements for the period 1 January to 31 March 2018 ( the interim financial statements ) of Íslandsbanki hf. ( the Bank or Íslandsbanki ) and its subsidiaries (together referred to as "the Group"). Operations in the reporting period Íslandsbanki is a universal bank offering comprehensive financial services to households, corporations, and institutional investors in Iceland. The Group is one of Iceland's largest banking and financial services groups, with a strong domestic market share. The profit from the Group's operations for the reporting period amounted to ISK 2,097 million, which corresponds to 4.8% return on equity. At the end of the reporting period, the Group employed 1,027 full-time members of staff, including 843 within the Bank itself. Net interest income increased by 5% between years, due to balance sheet growth. Net fee income was down by 15%, where strong growth in the Bank was offset by reduced activity in Borgun and Hringur, subsidiaries of the Bank. Net financial loss was by ISK 283 million, the loss derives largely from losses in mark-to-market of derivative hedges and losses on equity trading. Administrative expenses were up by 6.7% between years, partly as a result of reduced capitalisation of salaries in 2018 due to an investment in the Bank's core banking systems. Net impairments were positive by ISK 88 million as the loan book continued to perform well on the back of a strong economy. Profit from discontinued operations amounted to ISK 713 million, mainly resulting from the sale of listed equities from a subsidiary of the Bank. The implementation of the new accounting rules for financial instruments (IFRS 9) resulted in an increase in the allowance account of ISK 3,358 million at 1 January 2018 as a result of the introduction of the new expected credit loss impairment model. The total effect of ISK 4,010 million, including the other changes due to the implementation of IFRS 9 (net of tax), has reduced shareholders' equity at 1 January The CET1 capital ratio reduced by 25 basis points. Note 3 provides more information. Figures for previous periods have not been restated. The Group's balance sheet grew by 5.1% in the quarter on the back of a 2.8% growth in loans to customers and considerable growth in liquid assets. As a result of the IFRS 9 implementation, the Bank is re-assessing its measurements and targets for loan book quality. Customer deposits increased by 1.4% during the quarter and the customer deposit-to-loan ratio was 74.1% at the end of the period. The Bank continues to have good access to capital markets. The Bank issued a 300m 6 year non-call 5 year bond in January priced at 75 basis points above 5-year mid swaps. The issuance was very well received by investors and was four times oversubscribed. In the domestic market, the Bank has issued ISK 3.3 billion of commercial papers and ISK 9.5 billion of covered bonds, thereby making good progress with the 2018 issuance plan of ISK billion for covered bonds. The Group's total equity amounted to ISK billion and total assets were ISK 1,088.3 billion at the end of the reporting period and the Group's total capital ratio was 21.4%. The Bank's liquidity position remains strong and well above regulatory requirements. On 22 March 2018, Íslandsbanki's Annual General Meeting approved the Board's proposal to pay ISK 13 billion dividend of the profit for 2017 to the Bank's shareholders. The dividend was paid to the shareholders on 28 March The Board was also authorised to call an extraordinary shareholders' meeting later in the year to propose payment of additional dividends if the Bank's accumulated capital reserves are considered to exceed its long-term capital requirements. Outlook Economic growth is slowing down in Iceland and falling in line with OECD peers. The growth rate peaked at 7.5% in 2016, slowed to 3.6% in 2017 and is expected to be at around 2.3% in The main sources of growth are shifting from the corporate sector to households, from exports and business investment to private consumption and residential investment. Private consumption growth is however moderating due to slower real wage growth and reduced population growth, but still expected to grow by a relatively healthy 4.7% in 2018, and by 3.0% in Iceland's net external position was positive by ISK 190bn, or 7.5% of GDP, at the end of 2017, the best IIP (International investment position) in Iceland's modern economic history. Gross central government debt has at the same time decreased from 88% of GDP to 41% of GDP over the past 7 years. As the Bank's earnings are closely related to the momentum of the economy, the growth in the balance sheet can be expected to moderate from the figures seen in 2017 and the first quarter of The Bank's challenge will be to reach target earnings in this period and manage the increased earnings volatility which is expected to come as a result of the IFRS 9 implementation. Financial Statements first quarter

5 Directors' Report Statement by the Board of Directors and the CEO The interim financial statements for the period 1 January to 31 March 2018 have been prepared on a going concern basis in accordance with the International Accounting Standard (IAS) 34 Interim Financial Reporting as adopted by the European Union; the Act on Annual Accounts, no. 3/2006; the Act on Financial Undertakings, no. 161/2002; and rules on accounting for credit institutions, where applicable. To the best of our knowledge, these interim financial statements provide a true and fair view of the Group's operating profits and cash flows in the reporting period and its financial position as of 31 March The Board of Directors and the CEO have today discussed and approved the Condensed Consolidated Interim Financial Statements for the period 1 January to 31 March Kópavogur, 9 May 2018 Board of Directors: Friðrik Sophusson, Chairman Helga Valfells, Vice-Chairman Anna Þórðardóttir Auður Finnbogadóttir Árni Stefánsson Hallgrímur Snorrason Heiðrún Jónsdóttir Chief Executive Officer: Birna Einarsdóttir Financial Statements first quarter

6 Consolidated Interim Income Statement Notes Interest income... Interest expense... Net interest income 14,995 13,852 ( 7,255) ( 6,455) 10 7,740 7,397 Fee and commission income... Fee and commission expense... Net fee and commission income 4,273 5,129 ( 1,495) ( 1,859) 11 2,778 3,270 Net financial (expense) income... Net foreign exchange (loss) gain... Other operating income... Other net operating income Total operating income 12 ( 283) ( 10) ( 280) ,238 11,040 Salaries and related expenses... Other operating expenses... Contribution to the Depositors' and Investors' Guarantee Fund... Bank tax... Total operating expenses Profit before net impairment on financial assets Net impairment on financial assets... Profit before tax Income tax expense... Profit for the period from continuing operations Profit from discontinued operations, net of income tax... Profit for the period 15 ( 3,926) ( 3,659) 16 ( 2,924) ( 2,759) ( 292) ( 253) ( 785) ( 720) ( 7,927) ( 7,391) 2,311 3, ,399 3, ( 1,015) ( 1,130) 1,384 2, ,097 3,044 Profit attributable to: Shareholders of Íslandsbanki hf.... Non-controlling interests... Profit for the period 2,186 2,955 ( 89) 89 2,097 3,044 Earnings per share from continuing operations Basic and diluted earnings per share attributable to the shareholders of Íslandsbanki hf The notes on pages 11 to 57 are an integral part of these Condensed Consolidated Interim Financial Statements. Financial Statements first quarter Amounts are in ISK million

7 Consolidated Interim Statement of Comprehensive Income Profit for the period... 2,097 3,044 Items that are or will be reclassified to profit or loss: Foreign currency translation differences for foreign operations... Net change in fair value of financial assets and financial liabilities, net of tax... Other comprehensive income for the period, net of tax Total comprehensive income for the period ,399 3,245 The notes on pages 11 to 57 are an integral part of these Condensed Consolidated Interim Financial Statements. Financial Statements first quarter Amounts are in ISK million

8 Consolidated Interim Statement of Financial Position Assets Notes Cash and balances with Central Bank... Bonds and debt instruments... Shares and equity instruments... Derivatives... Loans to credit institutions... Loans to customers... Investments in associates... Property and equipment... Intangible assets... Other assets... Non-current assets and disposal groups held for sale... Total Assets , , ,140 27, ,208 10, ,673 2, ,220 26, , , ,025 7,128 4,412 4, ,732 9, ,048 2,766 1,088,308 1,035,822 Liabilities Deposits from Central Bank and credit institutions... Deposits from customers... Derivative instruments and short positions... Debt issued and other borrowed funds... Subordinated loans... Tax liabilities... Other liabilities... Non-current liabilities and disposal groups held for sale... Total Liabilities 30 13,563 11, , , ,104 5, , , ,838 9,505 7,908 7, ,028 35, , ,777 Equity Share capital... Share premium... Reserves... Retained earnings... Total equity attributable to the equity holders of Íslandsbanki hf. Non-controlling interests... Total Equity 10,000 10,000 55,000 55,000 4,991 6,179 93, , , ,566 2,416 2, , ,045 Total Liabilities and Equity 1,088,308 1,035,822 The notes on pages 11 to 57 are an integral part of these Condensed Consolidated Interim Financial Statements. Financial Statements first quarter Amounts are in ISK million

9 Consolidated Interim Statement of Changes in Equity Liability Total Non- Share Share Restricted Fair value credit Other Retained shareholders' controlling Total capital premium reserves reserve reserve reserves earnings equity interests equity Equity as at ,000 55,000 1,673 ( 25) - 2, , ,702 4, ,925 Profit for the period... 2,955 2, ,044 Dividends paid... ( 10,000) ( 10,000) ( 1,405) ( 11,405) Net change in fair value of AFS financial assets Translation differences for foreign operations Restricted due to capitalised development cost ( 382) - - Restricted due to fair value changes... 8 ( 8) - - Restricted due to subsidiaries and associates ( 269) - - Equity as at ,000 55,000 2, ,496 97, ,787 2, ,765 Equity as at ,000 55,000 3, , , ,566 2, ,045 Impact of adopting IFRS 9, see Note 3... ( 1,486) ( 2,530) ( 4,016) 6 ( 4,010) Impact of adopting IFRS 15, see Note 3... ( 97) ( 97) ( 97) Equity as at ,000 55,000 3, ( 1,486) 2, , ,453 2, ,938 Profit for the period... 2,186 2,186 ( 89) 2,097 Dividends paid... ( 13,000) ( 13,000) ( 13,000) Net change in fair value of financial assets through OCI Net change in fair value of financial liabilities Restricted due to capitalised development cost ( 164) - - Restricted due to fair value changes... ( 107) Restricted due to subsidiaries and associates... ( 41) Equity as at ,000 55,000 3, ( 1,237) 2,500 93, ,921 2, ,337 Dividends: The Annual General Meeting ("AGM") for the operating year 2017 was held on 22 March At the AGM shareholders approved the Board's proposal to pay dividends to shareholders for the financial year Dividends amounting to ISK 13,000 million were paid on 28 March 2018 which is equivalent to ISK 1.30 per share (2017: ISK 1.00 per share). The notes on pages 11 to 57 are an integral part of these Condensed Consolidated Interim Financial Statements. Financial Statements first quarter Amounts are in ISK million

10 Consolidated Interim Statement of Cash Flows Cash flows from operating activities: Profit for the period Notes ,097 3,044 Non-cash items included in profit for the period... Changes in operating assets and liabilities... Dividends received... Income tax and bank tax paid... 4,084 2,599 ( 49,483) ( 49,907) ( 883) ( 292) Net cash (used in) operating activities ( 44,174) ( 44,527) Net investments in associated companies... Proceeds from sale of property and equipment... Purchase of property and equipment... Purchase of intangible assets... - ( 12) 4 4 ( 64) ( 343) ( 232) ( 397) Net cash (used in) investing activities ( 292) ( 748) Proceeds from borrowings... Repayment of borrowings... Dividends paid... Dividends paid non-controlling interests... 55,299 11,741 ( 3,428) ( 3,936) ( 10,140) ( 449) - ( 1,405) Net cash provided by financing activities 41,731 5,951 Net (decrease) in cash and cash equivalents... Effects of foreign exchange rate changes... Cash and cash equivalents at the beginning of the period... ( 2,735) ( 39,324) ( 60) ( 16) 187, ,263 Cash and cash equivalents at the end of the period 184, ,923 Reconciliation of cash and cash equivalents: Cash on hand... Cash balances with Central Bank... Bank accounts... Mandatory reserve and special restricted balances with Central Bank ,025 3, , , ,702 13, ( 15,088) ( 22,849) Cash and cash equivalents at the end of the period 184, ,923 The Group has prepared its consolidated interim statement of cash flows using the indirect method. The statement is based on the net profit after tax for the period and shows the cash flows from operating, investing and financing activities and the increase or decrease in cash and cash equivalents during the period. Interest received from 1 January to 31 March 2018 was ISK 14,170 million (2017: ISK 15,569 million) and interest paid in the same period 2018 was ISK 4,224 million (2017: ISK 5,408 million). Interest paid is defined as having been paid when it has been deposited into the customer account and is available for the customer's disposal. The notes on pages 11 to 57 are an integral part of these Condensed Consolidated Interim Financial Statements. Financial Statements first quarter Amounts are in ISK million

11 Consolidated Interim Statement of Cash Flows Non-cash items included in profit for the period: Depreciation and impairment... Amortisation of intangible assets... Share of loss (gain) of associates... Accrued interest and fair value changes on debt issued... Impairment on loans... Net impairment on financial assets... Foreign exchange loss (gain)... Net (gain) on sale of property and equipment... Unrealised fair value losses recognised in profit and loss... Net profit on non-current assets classified as held for sale... Bank tax... Income tax ( 263) 2,500 1,341 - ( 397) ( 88) ( 201) ( 1) ( 2) ( 713) ( 285) 1,015 1, Non-cash items included in profit for the period 4,084 2,599 Changes in operating assets and liabilities: Mandatory reserve and special restricted balances with Central Bank... Loans and receivables to credit institutions... Loans and receivables to customers... Trading assets... Other operating assets... Non-current assets and liabilities held for sale... Deposits with credit institutions and Central Bank... Deposits from customers... Trading financial liabilities... Derivatives... Other operating liabilities... 2,478 24,344 ( 16,038) ( 15,597) ( 28,784) ( 13,803) ( 23,848) ( 12,934) ( 432) ( 7,121) 2,440 1,392 2,500 6,339 11,127 ( 27,420) ( 270) 14 1,105 ( 140) 239 ( 4,981) Changes in operating assets and liabilities ( 49,483) ( 49,907) Non-cash transactions 2018 The Bank paid dividends amounting to ISK 13,000 million. Thereof are non-cash transactions amounting to ISK 2,860 million which is capital income tax due in May Non-cash transactions 2017 The Bank paid dividends amounting to ISK 10,000 million. Thereof are non-cash transactions amounting to ISK 7,551 million which were paid with a government bond. The notes on pages 11 to 57 are an integral part of these Condensed Consolidated Interim Financial Statements. Financial Statements first quarter Amounts are in ISK million

12 Notes Page Notes Page General information 1 Corporate information Investments in associates Basis of preparation Investments in subsidiaries Changes to accounting policies Other assets Operating segments Non-current assets and disposal groups held for sale Deposits from Central Bank and credit institutions Notes to the Statement of Comprehensive Income 31 Deposits from customers Quarterly statements Pledged assets Net interest income Debt issued and other borrowed funds Net fee and commission income Subordinated loans Net financial (expense) income Changes in liabilities arising from 13 Net foreign exchange (loss) gain financing activities Other operating income Other liabilities Salaries and related expenses Other operating expenses Other Notes 17 Net impairment on financial assets Related party Income tax expense Custody assets Profit from discontinued operations Contingencies Earnings per share Events after the reporting period Notes to the Statement of Financial Position Risk Management 5 Classification of financial assets and liabilities Risk management Fair value information for financial instruments Credit risk Offsetting financial assets and financial liabilities Liquidity risk Cash and balances with Central Bank Market risk Derivative instruments and short positions Interest rate risk Loans to credit institutions Currency risk Loans to customers Derivatives Expected credit loss Inflation risk Capital Management Financial Statements first quarter

13 1. Corporate information Íslandsbanki hf. the parent company was incorporated on 8 October 2008 and is a limited liability company domiciled in Iceland. The condensed consolidated interim financial statements for the first quarter 2018 ( the interim financial statements ) comprise the financial statements of Íslandsbanki hf. ( the Bank or Íslandsbanki ) and its subsidiaries together referred to as "the Group". The interim financial statements were authorised for issue by the Board of Directors of Íslandsbanki hf. on 9 May Basis of preparation The interim financial statements have been prepared in accordance with the International Accounting Standard (IAS) 34 Interim Financial Reporting, as adopted by the European Union and additional requirements in the Act on Annual Accounts no. 3/2006, the Act on Financial Undertakings no. 161/2002 and rules on accounting for credit institutions. The interim financial statements do not include all the information required for annual financial statements and should be read in conjunction with the audited consolidated financial statements of the Group for the year ended 31 December 2017, as well as the unaudited Pillar 3 Report for the year ended 31 December Both are available on the Bank's website At 1 January 2018, the Group implemented IFRS 9 - Financial Instruments, and IFRS 15 - Revenue from Contracts with Customers. The impact from the implementation of IFRS 9 and IFRS 15 on the opening balance sheet at 1 January 2018 is disclosed in Note 3. The Group's management has made an assessment of the Group's ability to continue as a going concern and is satisfied that the Group has the resources to continue in business for the foreseeable future. Therefore, the interim financial statements have been prepared on a going concern basis. The interim financial statements have been prepared on an historical cost basis except for the following items in the statement of financial position: bonds and debt instruments which are measured at fair value, shares and equity instruments which are measured at fair value, derivative financial instruments which are measured at fair value and non-current assets and disposal groups classified as held for sale which are measured at the lower of its carrying amount and fair value less costs to sell. Recognised financial liabilities designated as hedged items in qualifying fair value hedge relationships are measured at amortised cost adjusted for changes in fair value attributable to the risk being hedged. The interim financial statements are presented in Icelandic króna (ISK), which is the functional currency of Íslandsbanki hf. All amounts presented in ISK have been rounded to the nearest million, except when otherwise indicated. Important accounting estimates and judgements The preparation of the interim financial statements requires management to make judgements, estimates and assumptions that affect the application of accounting policies and the reported amounts of assets, liabilities at the date of the interim financial statements, and income and expenses recognised during the reporting period. Estimates made by management are based on historical experience and other assumptions that are believed to be reasonable. Key areas where management has made difficult, complex or subjective judgements, include those relating to the allowance for credit losses, the fair value of financial instruments, including derivatives and derecognition of financial assets and liabilities. While management makes its best estimates and assumptions, actual results could differ from these estimates and assumptions. 3. Changes to accounting policies The accounting policies in the interim financial statements are consistent with those applied in the Group's audited consolidated financial statements for the year ended 31 December 2017, except for changes to the accounting for financial instruments resulting from the adoption of IFRS 9, and the accounting for revenue from contracts with customers resulting from the adoption of IFRS 15. Those changes are described below. IFRS 9 Financial Instruments The Group adopted a new IFRS standard, IFRS 9 - Financial Instruments, which replaced IAS 39 as of 1 January As a result of the application of IFRS 9, the Group changed its accounting policies in the areas outlined below, and these new policies were applicable from 1 January As permitted by the transition provisions of IFRS 9, the Group elected not to restate comparative period information; accordingly, all comparative period information is presented in accordance with previous accounting policies, as described in the Group's audited consolidated financial statements for the year ended 31 December Adjustments to carrying amounts of financial assets and financial liabilities at the date of initial application were recognised in equity as of 1 January New or amended interim disclosures have been provided for the current period, where applicable, and comparative period disclosures are consistent with those made in the prior year. Financial Statements first quarter

14 3. Cont'd Classification and measurement Financial assets Financial assets are classified into one of three measurement categories, i.e. measured subsequently at amortised cost, measured subsequently at fair value through other comprehensive income or measured subsequently at fair value through profit or loss. The measurement basis of individual financial assets is determined based on an assessment of the cash flow characteristics of the assets and the business models under which they are managed. Reclassification between measurement categories is required if the objective of the business model in which the financial assets are held changes after initial recognition and if the change is significant to the Group's operations. The business models The business models are determined by the Group's key management personnel in the way that assets are managed and their performance is reported to them. The Group determines its business models at a level that reflects the way groups of financial assets are managed together to achieve a particular business objective. This condition is not an instrument-by-instrument approach to classification, but is determined at a higher level of aggregation. The Group's business models fall into the following three categories: Held to collect, Held to collect and for sale, and Other fair value business models, where assets are held for trading or managed on a fair value basis and are neither Held to collect nor Held to collect and for sale. Solely payments of principal and interest ( SPPI ) Financial assets held within the business models Held to collect and Held to collect and for sale, are assessed to evaluate if their contractual cash flows are comprised of solely payments of principal and interest. SPPI payments are those which are consistent with a basic lending arrangement. Principal is the fair value of the financial asset at initial recognition and changes over the life of the financial asset, for example if there are repayments of principal. Interest relates to basic lending returns, including compensation for the time value of money and credit risk associated with the principal amount outstanding over a period of time. Interest can also include consideration for other basic lending risks (for example, liquidity risk) and costs (for example, servicing or administrative costs), as well as a profit margin that is consistent with a basic lending arrangement. Where the contractual terms introduce exposure to risk or variability of cash flows that are inconsistent with a basic lending arrangement, the related financial asset is classified and measured at fair value through profit or loss. Financial assets at amortised cost A financial asset is classified as being subsequently measured at amortised cost if the contractual terms of the financial asset give rise to cash flows that are solely payments of principal and interest and the asset is held within a business model whose objective is to collect contractual cash flows, i.e. Held to collect. Financial assets at amortised cost are measured using the effective interest method. Amortised cost is calculated by taking into account the amount at which the assets are measured at initial recognition less principal repayments, plus or minus the cumulative amortisation using the effective interest method of any difference between that initial amount and the maturity amount (such as due to discounts or premiums on acquisition and fees and costs that are an integral part of the effective interest rate), and minus any reduction for impairment. Accrued interest is included in the carrying amount of the financial asset in the statement of financial position. Impairment losses, reversals of impairment losses and impairment gains are recognised in profit or loss in the line item Net impairment on financial assets. Financial Statements first quarter

15 3. Cont'd Financial assets at fair value through other comprehensive income (FVOCI) Equity instruments at FVOCI For equity instruments that are not held for trading, an irrevocable election can be made at initial recognition, to recognise unrealised and realised fair value gains and losses, including any related foreign exchange component, in other comprehensive income rather than profit or loss. This election is made on an instrument-by-instrument basis. Equity instruments at FVOCI are not subject to an impairment assessment. Dividends are to be presented in profit or loss, as long as they represent a return on investment. On derecognition there is no recycling of fair value gains and losses to profit or loss. Debt instruments at FVOCI During the period the Group did not classify any debt instruments at FVOCI. Financial assets at fair value through profit or loss (FVTPL) Financial assets classified at fair value through profit or loss are all other financial assets which are not classified at amortised cost or at fair value through other comprehensive income. This includes financial assets classified mandatorily at fair value through profit or loss and financial assets which are irrevocably designated by the Group at initial recognition as at fair value through profit or loss that would otherwise meet the requirements to be measured at amortised cost or at FVOCI. The Group designates financial assets as at fair value through profit or loss if doing so eliminates or significantly reduces an accounting mismatch that would otherwise arise. During the period the Group did not classify any financial assets as designated at fair value through profit or loss. Financial assets at fair value through profit or loss are initially recognised and subsequently measured at fair value in the statement of financial position, with transaction costs recognised immediately in profit or loss. Changes in fair value are recognised in profit or loss in the line item "Net financial income (expense)", except for interest earned, which is recognised in the line item "Interest income" using the effective interest method and foreign exchange gains and losses, which are included in the line item "Net foreign exchange gain (loss)". Financial liabilities Financial liabilities designated as at fair value through profit or loss Financial liabilities designated as at fair value through profit or loss are recognised at fair value and changes in fair value attributable to changes in the credit risk of those liabilities are recognised in other comprehensive income and are not subsequently reclassified to profit or loss. The remaining fair value changes are included in profit or loss in the line item "Net financial income (expense)", except for interest incurred, which is recognised as "Interest expense" on an accrual basis and foreign exchange gains and losses which are included in the line item "Net foreign exchange gain (loss)". The Group calculates the fair value attributable to changes in credit risk as the difference between the changes in fair value of the financial liability and the amount of changes in fair value attributable to changes in market interest rates. The change in fair value attributable to changes in market interest rates on financial liabilities is calculated by discounting contractual cash flows at the end of the period with the discount rate of the appropriate market interest rate. Upon initial recognition, the Group determines if the recognition of gains and losses in other comprehensive income creates or enlarges an accounting mismatch in profit or loss, then the whole fair value change is presented in profit or loss. This is not applicable for the Group during the period. Hedge accounting The Group has elected to continue to apply the hedge accounting principles under IAS 39 instead of those under IFRS 9. The policy for hedge accounting is described in Note 76.9 in the Group's audited consolidated financial statements for the year ended 31 December Financial Statements first quarter

16 3. Cont'd Impairment The adoption of IFRS 9 has had a significant impact on the Group's impairment methodology. The two main reasons for this impact are firstly that the impairment model of IFRS 9 is forward-looking as opposed to the incurred loss model of IAS 39 and secondly that impairment under IFRS 9 should reflect a probability weighted average of possible outcomes in contrast to IAS 39 where the single most likely outcome was accounted for. In addition, the expected credit loss model in IFRS 9 employs a dual measurement approach, under which the loss allowance for expected credit losses (ECL) is measured at each reporting date as either 12-month expected credit losses or lifetime expected credit losses, depending on whether there has been a significant increase in credit risk (SICR) of the financial instrument since initial recognition. To satisfy the provisions of the IFRS 9 standard, a significant amount of modelling must be involved. The models which the Group uses for the calculation of the impairment amount are developed according to the Group's modelling framework. This framework imposes structure on the initial model development work, the model documentation including educational material as needed for users, the approval process for models, the implementation of models and the lifetime support for models, including validation and back-testing. The Group's impairment process, which encompasses all the steps needed to derive the appropriate impairment allowance for each accounting period, is documented and approved by the All Risk Committee. Stage assignment At each reporting date, all assets subject to the impairment methodology must be divided into three groups, termed Stages, reflecting the extent of credit deterioration since initial recognition. This division then has an effect on how the impairment is measured and how interest is recognised. Stage 1 All assets that have not experienced a significant increase in credit risk (SICR) are assigned to Stage 1. For these assets, an impairment allowance is recognised which is equal to the expected credit loss arising from credit events occurring within 12 months of the reporting date (12-month ECL). Interest is recognised on the gross carrying amount of the assets. Stage 2 Assets that the Group determines to have experienced a SICR, but are not credit-impaired, are classified as Stage 2. For these assets, an impairment allowance is recognised which is equal to the expected credit loss arising from all credit events occurring within the expected lifetime of the assets (lifetime ECL). Interest is recognised on the gross carrying amount of the assets. Stage 3 This Stage is for assets which are credit-impaired according to the Group's assessment. These assets are therefore experiencing an ongoing credit event. Thus, the 12-month ECL and lifetime ECL are the same amount and this amount is recognised as impairment allowance. For assets in this Stage, interest is recognised on the carrying amount of assets, net of impairment allowance. The Group's definition of being credit-impaired is on a customer level, rather than on the level of an individual asset. According to the definition, a customer is credit-impaired when either of the following holds: a) The Group assesses that it is unlikely that the customer can service all of their commitments to the Group in accordance with the terms of the agreements without recourse to default provisions in the agreements. b) The customer is more than 90 days past due on any of their commitments. The assessment in point a) is made based on a defined set of triggers, which includes serious breach of covenants, serious registrations on an internal watchlist, initiation of serious collection actions and serious external credit related information. Furthermore, there is a defined set of conditions which must be satisfied so that customers that have been assessed as being creditimpaired are no longer subject to this assessment. This includes probation periods and a view to the future outlook of the customer. The Group's definition of a SICR is on the level of an individual asset. The Group assesses that there has been a significant increase in credit risk of an asset if the probability of a credit impairment event, i.e. transfer to Stage 3, occurring over the lifetime of the asset has increased significantly from the origination of the assets. For this purpose, origination does not refer to any modification events which have not resulted in derecognition of the asset. The assessment is based on a defined set of triggers. This includes, as a backstop, the trigger that the asset is more than thirty days past due. Other triggers are internal assessments of outlook, events such as forbearance events which are less severe than a credit event, external credit related information and a significant deterioration in risk assessment compared with the risk assessment done in relation to the origination of the asset. The definition of SICR depends only on the probability of a credit event occurring, it does not take into account collateralisation or any other information related to the expected loss arising from the event. The Group does not employ the low credit risk exemption in the Stage assignment process. In alignment with its operating procedures, the Group has chosen as its accounting policy to measure the impairment allowance for lease receivables at an amount equal to the lifetime ECL only for those assets which have a SICR or are credit-impaired. For other lease receivables the impairment allowance is equal to the 12-month ECL. Financial Statements first quarter

17 3. Cont'd Expected credit loss (ECL) The ECL for each asset is calculated using models for the probability of a credit impairment event occurring (PD), the loss percentage expected in case of such an event (LGD) and the outstanding amount at the time of the event (EAD). In its simplest form the ECL can be calculated as the product of these factors, however, for several reasons, the actual formula must be more complicated than this. The Group uses the standardised approach for regulatory capital purposes but has used PD models and LGD models for risk management purposes for several years. These models have been adapted for IFRS 9 purposes. For EAD, and for LGD to a certain extent, new models have been developed. The PD models are either fully automated statistical models, expert models or hybrid. For the models with a component involving expert input there is a process in place to ensure proper review of the model outcome and periodic reassessment of obligors. The inputs into the models include demographic variables, information from financial statements and past payment behaviour, among other variables. The effects of the economy on the PD is accounted for through the use of scaling factors which map through-the-cycle PD values to point-in-time PD values. The Group has a model to predict these scaling factors based on economic forecasts. The economic forecasts used are provided at least quarterly by the Group's Chief Economist and approved by the All Risk Committee. The Group uses several economic scenarios which have different scaling factors in order to represent the whole range of possible future economic developments. The actual impairment allowance is the weighted average of the ECL in these different scenarios. The LGD model considers several scenarios for how a facility may develop once a credit event has occurred. One possibility is that the facility cures without a loss. If not, the recoveries may be based on the seizing of collateral and to estimate such recoveries it is appropriate to consider several scenarios for the development of the value of the collateral. Finally, there may be recoveries even though a formal collateral is not in place. These different recovery scenarios are weighted differently depending on the economic scenario under consideration. This leads to a non-linear interaction and thus a difference between the probability weighted average ECL and the ECL in the most likely scenario. For EAD it is necessary to account for expected prepayments on term loans and for the expected utilisation of commitments such as credit cards, overdrafts, financial guarantees and credit lines. The expected lifetime of agreements may also extend beyond the contractual lifetime for contracts which are generally extended. Write-off policy The Group writes off a financial asset, either partially or in full, when there is no realistic prospect of recovery. Where financial assets are secured, write-off is generally after receipt of any proceeds from the realisation of security. In subsequent periods, any recoveries of amounts previously written off are credited to the provision for credit losses in the consolidated interim income statement. The impairment process In the Group's impairment framework, the Stage assignment and ECL for each financial asset is calculated from the aforementioned models. The outcome is reviewed by the business units and they can propose changes if they provide sufficient supporting material. The impairment and any proposals for changes are reviewed by an Impairment Council appointed by the All Risk Committee and the impairment allowance is approved by the All Risk Committee on a quarterly basis. The principle of materiality applies to the above discussion on impairment, whereby exceptions related to non-materiality and immaterial adjustments are not discussed. Impact of adoption of IFRS 9 The IFRS 9 transition reduced shareholders' equity by ISK 4,010 million in total net of tax as at 1 January 2018, thereof ISK 2,484 million is due to changes in impairments and ISK 1,526 million due to reclassification of debt securities. The CET1 capital ratio reduced by 25 basis points. Financial Statements first quarter

18 3. Cont'd Transition of financial assets and financial liabilities The following table summarises the day one impact of the implementation of IFRS 9 showing the original measurement catagories in accordance with IAS 39 and the new measurement categories under IFRS 9 for the Group's financial assets and financial liabilites. At 1 January 2018 Classification Classification Closing balance Reclassi- Remeasure- Opening balance IAS 39 IFRS 9 IAS 39 fication ment IFRS 9 Cash and balances with Central Bank... Listed bonds and debt instruments... Listed bonds and debt instruments... Unlisted bonds and debt instruments... Listed shares and equity instruments... Listed shares and equity instruments... Unlisted shares and equity instruments... Unlisted shares and equity instruments... Derivatives... Derivatives... Loans to credit institutions... Loans to customers... Other financial assets... Loans & receivables Amortised cost 189, ,045 Held for trading Mandatorily at FVTPL 24, ,716 Designated as at FVTPL* Mandatorily at FVTPL Designated as at FVTPL* Mandatorily at FVTPL 2, ,001 Held for trading Mandatorily at FVTPL 5, ,108 Designated as at FVTPL Mandatorily at FVTPL 1, ,645 Designated as at FVTPL Mandatorily at FVTPL 2, ,188 Available for sale Fair value through OCI 1, ,236 Held for trading Mandatorily at FVTPL 2, ,896 Held for hedging Held for hedging** 5 ( 5) - - Loans & receivables Amortised cost 26,617 - ( 39) 26,578 Loans & receivables Amortised cost 755,175 - ( 2,706) 752,469 Loans & receivables Amortised cost 9,847 - ( 3) 9,844 Total financial assets 1,020,847 - ( 2,748) 1,018,099 Deposits from CB and credit institutions... Deposits from customers... Derivative instruments and short positions... Derivative instruments and short positions... Debt issued and other borrowed funds... Debt issued and other borrowed funds... Subordinated loans... Other financial liabilities... Amortised cost Amortised cost 11, ,189 Amortised cost Amortised cost 567, ,029 Held for trading Mandatorily at FVTPL 5, ,492 Held for hedging Held for hedging** 421 ( 421) - - Designated as at FVTPL Designated as at FVTPL*** - 82,655 1,908 84,563 Amortised cost Amortised cost 217,748 ( 82,655) - 135,093 Amortised cost Amortised cost 9, ,505 Amortised cost Amortised cost 10, ,467 Total financial liabilities 821,430-1, ,338 Financial Statements first quarter Amounts are in ISK million

19 3. Cont'd *At the date of initial application of IFRS 9 the Group reclassified certain debt instruments from designated as at FVTPL to mandatorily at FVTPL. These debt instruments are managed and evaluated on a fair value basis and are therfore to be mandatorily measured at fair value through profit or loss. No debt instruments are classified as designated at fair value through profit or loss or at fair value through OCI. **IFRS 9 includes new hedge accounting rules, which align hedge accounting more closely with risk management. IFRS 9 includes an accounting policy choice to defer the adoption of IFRS 9 hedge accounting and to continue with IAS 39 hedge accounting. The Group has decided to exercise this accounting policy choice. On 1 January 2018 the Group discontinued applying hedge accounting for certain euro denominated debt securities and interest rate swaps. ***At the date of initial application of IFRS 9 the Group changed the classification of certain debt securities to being designated as at fair value through profit or loss. The impact of this change on 1 January 2018 was ISK 1,908 million. Allowance for credit losses The following table is a comparison of impairment allowances determined in accordance with IAS 39 and IAS 37 to the corresponding impairment allowance determined in accordance with IFRS 9 as at 1 January Collectively Individually Transition assessed assessed Total adjustments Stage 1 Stage 2 Stage 3 Total Loans at amortised cost* 1,729 8,662 10,391 2,745 2,741 1,244 9,151 13,136 Other assets at amortised cost Off-balance sheet loan commitments and financial guarantees Total allowance for credit losses 1,729 8,731 10,460 3,358 3,214 1,347 9,257 13,818 *Loans at amortised cost includes Loans to customers and Loans to credit institutions. Financial Statements first quarter Amounts are in ISK million

20 3. Cont'd IFRS 15 Revenue from Contracts with Customers IFRS 15 Revenue from contracts with customers became effective as at 1 January 2018 and replaced various IFRS standards and interpretations on revenue recognition related to sale of goods and services. IFRS 15 establishes a single comprehensive framework for accounting for revenue arising from sale of goods and services through contracts which fall under its scope. IFRS 15 does not apply to revenue arising from financial instruments but it applies to fees charged by the Group which are not part of the effective interest rate of a financial instrument. The Group adopted IFRS 15 by applying the cumulative effect method, under which the effect of initial adoption was recognised in equity on 1 January 2018 and comparative information was not restated. The Group recognised ISK 97.4 million as a decrease in retained earnings as at 1 January 2018 due to the adoption of IFRS 15. This change is due to the change in revenue recognition for insurance broker commissions, whereas the transaction price now reflects a refund liability due to contractual provisions in the contract with the insurance provider, which is the principal in the transaction, and a related refund asset due to commissions paid by the Group to sale agents. Apart from this change the adoption of IFRS 15 did not result in changes to the timing or amount of revenue recognition. However, the Group changed the presentation in the consolidated income statement of insurance and wholesale annual fees related to credit cards, whereas they were presented as an expense in the line item Fee and commission expense before 1 January 2018 but they are presented as a deduction from revenue in the line item Fee and commission income from 1 January This change in presentation has no effect on the net fee and commission income. 4. Operating segments The Bank announced changes to its organisational structure in the second quarter of The purpose of the changes is to adapt the Bank's organisational structure to customers' changed needs and provide them with better banking services. The changes have not been fully implemented. Now Retail Banking and Corporate & Investment Banking serve the customers. Wealth Management and Markets no longer operate as separate segments but have been incorporated into the existing segments. Retail Banking is currently comprised of Personal Banking and Business Banking, however once the organisational changes have been fully implemented the two new segments will replace Retail Banking. The Bank will then have three income-generating units: Personal Banking, Business Banking and Corporate & Investment Banking. Comparative amounts have not been adjusted. The Group is currently organised into four main operating segments: Retail Banking Personal Banking provides comprehensive financial services to individuals, such as lending, savings and payments and Business Banking provides wide-ranging financial services to small- and medium-sized enterprises. Comprehensive consultancy services are conducted by experienced advisors located throughout the branches. Business Banking operates Ergo, the asset based financing unit of the Bank. Personal Banking operates Kreditkort, a specialised brand in the credit card sector and Kass, a mobile payments platform. Corporate & Investment Banking Corporate & Investment Banking provides universal banking services to large companies, municipalities, institutional investors and affluent individuals. The experienced team members provide customised products and services to customers including lending and advisory, risk management, brokerage and private banking services. The division is sector-focused, building and maintaining relationships with key customer segments within Iceland. Outside of Iceland, Íslandsbanki has a special focus on the North Atlantic seafood industry, leveraging its expertise in the domestic market and global contacts. Treasury Treasury is responsible for funding the Bank's operations and for managing the internal pricing framework. Treasury is also responsible for the Bank's balance sheet management and for the relations with investors, financial institutions, stock exchanges and rating agencies. Proprietary Trading and Subsidiaries Proprietary Trading and Subsidiaries include equity and debt investments in the trading book and banking book as well as the impact of subsidiaries and associates. For further information regarding subsidiaries and associates see Note 26 and Note 27. Cost centres comprise Head Office (Human Resources, Communications, Strategy & Marketing and Legal), Finance, Operations & IT, Risk Management, Group Internal Audit, and Compliance. The accounting policies for the reportable segments are in line with the Group's accounting policies. The Group operates mainly in the Icelandic market. Following is an overview showing the Group's performance with a breakdown by operating segments. Financial Statements first quarter